Today's Lesson-Scarcity and Price

In the over consuming society we live, numerous examples of this problem exist. The most basic idea for this comes from the "diamond and water" paradox. It asks why water, the basis for all life on Earth is nearly free, while diamonds for jewelry--which serve no practical function, cost thousands of dollars. Simply, the reason is scarcity, as diamonds exist in smaller quantities and as such the demand is relatively inelastic(closer to a vertical line) while water is more elastic(closer to a horizontal line).



In simple terms, that means that the more diamonds are on the market, the demand is roughly the same so price does not move. Water on the other hand has such a nearly fixed price that creating new methods of obtaining it does not change the price by much. Water cannot ever be free, however, as price acts as a regulator of behavior. At a price of zero, waste is rampant, as occurred during free water projects in Africa in the 1990s.



On the other side, luxury goods have inflated values attached to them which lead to waste in the same manner as freeing a basic good. One result is that the perceived status carries an economic value, resulting in irrational economic decisions. This distortion of real value causes people who purchase luxury goods beyond their means to engage in economically disadvantageous behavior, such as paying high interest credit or fractional ownership, leading to much greater financial pain than simply purchasing the good outright.